Savers planning to make ad-hoc pension withdrawals in the new tax year could face being overtaxed by thousands of pounds, AJ Bell has warned.
According to the group, those who are overtaxed may have to wait at least 12 months to claim back their money or could need to contact HM Revenue & Customs (HMRC) to ask for it back.
The problem can affect anyone who takes a taxable pension freedoms payment from the age of 55, it added – either through drawdown or via an uncrystallised funds pension lump sum or ‘UFPLS’ withdrawal.
AJ Bell explained that, in these circumstances, HMRC requires pension providers to use an emergency ‘Month 1′ tax code, meaning the Revenue only gives one-twelfth of the usual tax allowances available on the withdrawal, resulting in many savers being “severely overtaxed”.
Someone who makes a £2,000 withdrawal, for example, could be overtaxed by more than £200, while someone taking out £10,000 could be overtaxed by more than £3,000.
AJ Bell senior analyst Tom Selby said tens of thousands of people risk falling into this tax trap.
“The problem is at its most acute at the beginning of the tax year as anyone who makes an ad-hoc withdrawal and does not fill out the right form to claim the money back will have to wait until at least April 2019 to get their money back,” he said.
“Even then, you are relying on the efficiency of HMRC to put you back in the position you should have been in in the first place.”
Selby said some 140,000 pension pots have been accessed for the first time every quarter since the pension freedoms were introduced, the vast majority of which were likely to have been taxed on a ‘Month 1′ basis.
“On average, however, only 10,500 official reclaim forms have been processed each quarter by HMRC – worth a total of £283m,” he added.
“Savers accessing their pensions for the first time using the freedoms understandably expect to receive the correct amount of money. HMRC should, at the very least, consult on its approach to single pension freedoms withdrawals and review the risks it poses to savers.
“Allowing providers to apply a ‘Month 12′ tax code would be a more consumer-focused solution, with HMRC taking responsibility for recouping any underpaid tax.”